Stochastic Permanent Breaks

Robert Engle and Aaron Smith

The Review of Economics and Statistics, 1999, vol. 81, issue 4, 553-574

Abstract: This paper bridges the gap between processes where shocks are permanent and those with transitory shocks by formulating a process in which the long-run impact of each innovation is time-varying and stochastic. In the stochastic permanent breaks (STOPBREAK) process, frequent transitory shocks are supplemented by occasional permanent shifts. Consistency and asymptotic normality of quasi-maximum-likelihood estimates is established, and locally best hypothesis tests of the null of a random walk are developed. The model is applied to relative prices of pairs of stocks and significant test statistics result. © 2000 by the President and Fellows of Harvard College and the Massachusetts Institute of Technology

Date: 1999
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Working Paper: Stochastic Permanent Breaks (1998)
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